The Record That Counts Is In Reach

One of the last stock-market records still standing might finally fall soon.

The Dow Jones Industrial Average ended Friday at 16064.77, its seventh straight weekly gain. Despite all this year’s hoopla, the Dow needs to climb another 155 points to reach a new inflation-adjusted high, according to calculations by William Hausman, an economic historian at the College of William & Mary in Williamsburg, Va.

By that measure, the magic number of 16219.52 would put the Dow at a level it hasn’t seen since Jan. 14, 2000 during the technology bubble’s height. Since then, the Dow is up 37% but the consumer-price index is up 38%, which means all the headline-grabbing records don’t mean quite so much.

Friday’s gain of 54.78 points left the Dow about 1% below a new inflation-adjusted high. Getting there “really confirms that we are in record territory,” Mr. Hausman says. “Then we can talk about whether we are headed for a bubble or whether the fundamentals are strong.”

An inflation-adjusted record would mean blue-chip Dow stocks have regained the real value lost in two deadening financial crises. In a way, investors finally could put behind them the Internet bubble, Sept. 11, 2001 terrorist attacks, accounting scandals such as Enron Corp., the housing bubble, collapse of Lehman Brothers Holdings Inc. and other costly stumbles.

It would mean that the “lost decade” during which stocks never surpassed their values of the 1990s finally is over, at least for the Dow. Of course, a new inflation-adjusted high also would be a reminder that stocks have done no better than tread water since 2000.

There are qualifiers. If you add in the effect of dividends and taxes, the “total return” of the Dow has risen more than 37%. With dividends included, the Dow probably hit a real record some months ago.

In addition, some economists don’t like using the consumer-price index, and people don’t actually buy all their assets at a top or a bottom. Still, inflation-adjusted records are a better measure of market value than unadjusted records.

The broad S&P 500 index remains far from an inflation-adjusted record. It would have to rise to 2088.48, a jump of 16% from Friday’s close of 1804.76, the index’s first above 1800.

The S&P trails the Dow because it moves more quickly to add young, highflying companies. Highfliers fall hard in bear markets, pushing the S&P down more than the Dow.

The Nasdaq Composite Index, which lost the majority of its value in 2000 and 2001, is nowhere near a record, inflation-adjusted or otherwise. It ended Friday at 3991.65.

One way to interpret all this is that blue-chip stocks represented by the Dow have nearly recovered from two bear markets, while the broader, more-volatile group represented by the S&P and the Nasdaq has farther to go.

Because consumer prices have risen only 2.4% a year since 2000, some investors have come to ignore inflation. Others believe financial markets are so sophisticated that they automatically adjust for inflation expectations.

Economists consider both those views foolish. Annual inflation of 2.4% a year becomes 38% in 14 years, and that is significant. “If the price of a stock goes up and inflation goes up the same amount, then you are not really better off,” says David Colander, a historian of economic thought at Middlebury College in Vermont. And if the rate of inflation is higher than the asset’s appreciation, you are worse off.

Professor Colander worries that stocks and other assets have moved too far, too fast since bottoming out in 2009 and are entering a new bubble.

Inflation is particularly important for people saving for retirement, says Ed Green, co-chief investment officer at Foster Group, which oversees more than $1.2 billion in West Des Moines, Iowa.

With interest rates tiny, it is hard for retired people to find a low-risk investment outside the stock market that will grow faster than inflation.

“People typically don’t do the math to see where they are on a real-return basis. They just look at nominal returns,” he says. “By the time they realize they aren’t keeping up with inflation, folks potentially can get farther and farther behind. Conservative investors have really become the sacrificial lamb” of the Federal Reserve’s low-interest-rate policy.

The Dow has returned to an inflation-adjusted record after a bear market just four times since 1899, said Mr. Hausman.

The first came on Dec. 29, 1905. Then the Dow fell into a bear market, defined as a drop of 20% or more, in January 1906. The index rebounded to a new inflation-adjusted record in 1927, but that bull market ended in 1929.

It took 30 years for the Dow to hit its third inflation-adjusted record, and that bull market lasted until early 1966. The fourth real record came in 1995. That bull market ended in 2000.